When it comes to maximizing valuation in an M&A transaction, Blank Rome Partner, Co-Chair, Corporate, M&A and Securities Practice Group Louis Rappaport says sellers only have one chance to make a good first impression. Sellers need to prepare in a variety of areas to increase their odds of landing the best deal, one of which is financial.
"You might be surprised how many entrepreneurs don't have a perfect command of their capitalization table," Rappaport says. "I've seen both from the buy-side and sell-side what I call the 'promises, promises syndrome,' where CEOs have told key employees that they are going to be getting equity or options or profits interests or phantom equity, and we get the cap table and none of that is shown there."
That, he said during the Philadelphia Smart Business Dealmakers Conference, creates a number of questions, such as how to execute in that scenario, how to manage expectations and how to get the right tax outcome.
"If you are an entrepreneur or someone advising an entrepreneur, make sure that they have the strong handle on their cap table, and particularly in the incentive equity space," he says. "There are a lot of flavors of incentive equity. They each have their different benefits and different challenges, but in many transactions it the phantom equity plan or the profits interests that are issued to key managers who really need to be incentivized appropriately to help an owner get through a material transaction, and frequently those things are not set up properly. So, getting the right advice on those issues up front is mission critical."
Employee classification is another area where issues commonly arise.
"You have folks that work full-time for you that you pay as consultants," Rappaport says. "We've seen that many times, particularly human-capital businesses, where individuals are improperly classified, and it creates situations where potential tax liabilities exist."
Where businesses operate in multiple states or has employees located in multiple states can lead to issues paying taxes. Companies might believe that they only need to pay taxes where the headquarters of the business is, which is often incorrect and can create significant issues.
Sellers should also create a transaction execution team in their organization.
"Too many times we see sellers, whether we're representing them or whether we're representing buyers on the other side, with the CEO who thinks he or she is going to keep the deal secret from the rest of the company — they can't tell their CFO, they can't tell their HR person," Rappaport says. "And then they say to us, All the communications have to flow through us. Representing buyers I get really afraid of that because frequently when that happens the CEO takes his or her eye off the ball and the business slides in its operations. The reality is that even beyond the advisers, you need that CFO, you need that HR person, you need to be able to build a team that is under the tent, confidentially obviously, in order to make sure that you can service the process."
Most business owners, he says, are not in the business of selling their business. So, they need help from the inside and the outside. And they should also bring on good advisers both from investment banking, legal, finance and accounting because having knowledgeable advisers is a significant aspect of making a good first impression.
"As buyer's counsel, that's one of the things that we look at as we are evaluating not just the management team, but who does the management surround themselves with?" he says. "I've done deals on the other side of really competent people who I've had spirited experiences with and I've had deals where I've had to teach the lawyer on the other side how to do an M&A transaction, and do most of their work. Frankly, I'd prefer somebody who's competent on that side so we can we know what the objectives are and can get the deals done."
